Vol.5 No.19, 23 September 2005
Merits of the Flat Tax
Britain’s leading political economist, Will Hutton, describes it as ‘batty’. But the current interest in a ‘flat tax’ – a rate that applies to everyone – has the merit that it opens up the generic issue of taxation. Thinking about taxation had atrophied into two schools – less tax or more tax. The less tax brigade is associated with the conservative, markets-only, slim-government view; while those who propose higher taxes think in terms of proactive equality-promoting government.
It is time we widened the discussion. Are current taxation methods optimum? What are taxes really for? And how can they best be collected?
Taxation has three main functions. First, it must raise revenue for governments. This implies that it should be reasonably easy to collect. There is little point in taxation that is more expensive to gather than it is worth.
The ‘flat tax’ has the advantage of being easy to understand and collect. It has been most successful in Eastern Europe, where revenue collection had virtually collapsed in the transition to capitalism. But its claim to have raised more revenue than before is based on collecting extra social security contributions on employment.
Where taxation authorities are reasonably effective, the flat tax involves a loss of revenue. The British Treasury has estimated that, for the same revenue, 25 – 30 million people would pay more under a flat tax. Top income earners would benefit most. Poorest people – who now pay no tax – would have to be protected from the worst effects by having a threshold allowance before the flat taxis applied. Those who would suffer most would be the middle earners, who would in effect subsidise the rich, and take on the entire burden of the poor.
The second function of taxation is to influence consumer and producer behaviour by encouraging certain activities and discouraging others. Taxes on smoking were designed not only to raise money but also to discourage smoking. Most of the complication around taxation is about allowances to encourage people to do some things – saving for pensions, educating children, caring for elderly people – and discouraging others, like boozing and using fuel-guzzling motor vehicles and emitting toxins.
Some of these ‘green’ industrial taxes are already in operation in the EU and elsewhere. They regulate business practices to create a level playing field for benign activity, so as not to punish companies that behave well. In effect they tax ‘bads’ and reward ‘goods’.
The flat tax would altogether lose this second function. So governments would lose the power to influence behaviour, via prices affected by taxation.
The third function is as a tool to redistribute resources where incomes and wealth are very unequal. In all free market systems, access to wealth will tend to reproduce and deepen itself. The rich will enrich the opportunities for their children compared to those of poor people. Over time this produces deep injustices and the threat of social unrest. The current global historical phase is an excellent example.
Progressive taxation has been seen as a way to reverse that inequity as between people, classes and groups by producing different rates for different income levels.
The flat tax clearly has a negative effect here. It is the reverse of ‘progressive’. Its proponents rely on acceptance of inequality as an inevitable fact of life. Their main claim is that the flat tax so increases economic activity that unemployment and the current loss of revenues would be reversed within five years as growth kicks in.
This is no more than a reflection of the global illusion that growth can and will rescue all national economies from under-employment, inequality and social dis-ease. The German elections were all about that illusion: supporters of both main parties – at home and abroad – were divided only as to which would provide the growth. Neither can do so, because perpetual growth is no longer an option, especially for developed economies.
Clearly the flat tax is a non-starter. But current taxation systems could be improved by radical examination in the light of the three functions of taxation. The current model is massively bureaucratic both for citizens and for the authorities. Without professional help, we are lost in the jargon. The first characteristic of the bureaucrat must be paranoia: s/he must expect everyone to seeks means to evade their obligation.
That is not inevitable. For example, all transaction taxes are easy to collect, hard to evade and involve no complicated form-filling.
Take the Tobin tax. It would tax both buyers and sellers of national currencies, the tax being sent electronically and automatically to the relevant authority. Thus, each time the rand was bought and sold, a small proportion of its value would be sent to the Finance Ministry. The effect on trading would be to calm fluctuations in the value of the rand, a desirable outcome for all but speculators. The rich would pay most of it, as the poor trade very little in currencies.
The revenue effect would be spectacular. Globally $2 trillion is traded every day: work out for yourself how much revenue that would yield, even with a small rate of tax
Extend this to a tax on all transactions, and you have a veritable cornucopia, collected without difficulty, hard to evade and progressive in its effect. It would have to be complemented by other specific taxes on activities thought to be malign. But these would not have to meet the need for revenue. Think about it.
© South African New Economics Network 2006. Page generated at 17:04; 24 September 2006